EEA Mannheim 2015 (Part 4)

The last day of the EEA Meeting 2015 again offered a lot of high quality presentations. The highlight of the day was the Nobel session in honor of last year’s laureate Jean Tirole from Toulouse. At the conference dinner in the evening I even had the possibility to meet Prof. Tirole in person and to have a chat at the bar. He’s a very nice guy and very approachable.

This weekend there’s another conference in Munich, the Annual Conference of the European Association for Research in Industrial Economics. Since I’m currently sitting on the train, like probably 80% of the IO economists that attended the EEA, my impressions of the last day will remain rather short. But you should definitely have a closer look at these papers:

The positive relationship between human capital and economic growth and development is well established in the literature. Education creates a huge positive externality for society which justifies our highly subsidized educational system. When you look at historical data around the industrial revolution though the picture is quite different. Before the 19th century you find almost no correlation between proxies of human capital, like literacy rates, and development. The empirical findings on the relationship are mixed at best.

These findings are puzzling. Why seems education to not matter? Some historians proposed that education 200 years ago was focussed on the wrong subjects like philosophy, ancient languages or religion, which do not develop any technical skills. In most cases, the successful entrepreneurs of the Industrial Revolution in England acquired their skills on-the-job. Latin was certainly not important to James Watt to develop the steam engine.

The paper revisits the existing literature and emphasizes that existing papers looked at average human capital in a population and its relationship with growth. It could be the case, however, that not so much the average level of human capital drives growth but instead the presence of so-called knowledge elites. These elites are far to the right of a population’s skill distribution. In other words, technology adoption might not be driven by the John Does but by the MIT professors of the time (if it already had existed).

The authors measure these knowledge elites by the subscribers to the Great Encyclopédie in France and indeed find a positive relationship between these elites and economic growth in a region, at least for the period after 1750 when the Industrial Revolution gained traction in France. Of course, the paper has some endogeneity issues. Maybe the knowledge elites just moved to regions that were very vibrant culturally as well as economically. The empirical findings are interesting nevertheless.

Pharmaceutical markets are heavily regulated in Europe. The demand side is usually controlled by large health care providers that are tightly controlled by the state. Drugs are sold at different prices in different countries however. This creates arbitrage possibilities if you buy certain drugs cheaper, let’s say, in Poland and ship it to Norway. This kind of parallel trade is legal in Europe and even encouraged. The German state, for example, demands a parallel trade quota of 7% from its health care providers.

The authors look at the effect of parallel trade on the profit structure in Norway’s pharmaceutical market. Due to the regulatory system, there is basically no price competition for drugs in Norway. This means that lower costs from parallel trade directly increases margins at the wholesale level. But parallelly traded drugs might not be perfect substitutes for consumers. They are usually repackaged according to local standards but they still might look a little different than you’re used to. And if you essentially pay the same you might prefer the local version.

The incentive structure at the wholesale level, between producers and pharmacies, is not easy to understand. Both profit from higher margins for traded drugs. But if the share of traded drugs offered in a pharmacy is too high consumers might switch to another retailer. It turns out that as long as consumers have a preference for local drugs pharmacies need to be incentivized to offer traded drugs. This gives them a high bargaining power and lets them capture most of the profits resulting from parallel trade.